Portfolio Behavior of Commercial Banks in Bangladesh

Abstract

As a profit-seeking organization, commercial banks also try to have the highest profits by managing its portfolio. But for a successful and reliable activity and in a long-term perspective, the profits are not enough for a commercial bank. It is more important to the management to assure bank's liquidity to fulfill its obligations every moment it may be necessary. And un-doubtfully, besides the mentioned two principles of profitability and liquidity, it is of high importance for a bank to be safe, i.e. to minimize its risk. So, the successful management of a commercial bank is very careful in consideration of three important objectives: liquidity, safety, and income. In addition, they also evaluate their asset quality by calculating credit risk of loans they provide. To attain the objectives of liquidity, solvency, asset quality and profitability, commercial banks in practice need to set up a certain pattern and distribution of their assets in their portfolio composition. Management needs to decide as to what constitutes the best distribution of assets in the quest for attaining those objectives. However, the asset composition of all commercial banks in Bangladesh shows the high concentration of loans and advances in total assets in last seven years. In result, net interest income has been increased in all commercial banks though growth of some profitability indicators show negative trend in 2006. But the high concentration of loans and advances indicates vulnerability of assets to credit risk, especially since the portion of non-performing assets is significant. Because the more commercial banks are exposed to high-risk loans, the higher is the accumulation of unpaid loans, implying that these loan losses have produced lower returns to them. A huge infected loan portfolio has been the major difficulty of commercial banks. It appears that in aggregate, the banks have been continuously failing to maintain the required level of provisions against their NPLs. Liquidity indicators show a massive decreasing trend during the study period. The commercial banks of Bangladesh could not attain the required level due to shortage in owner's equity, provision shortfall and overburdened expenditure incurred from operation time to time. Hence, tl1e focus of the study is to provide an overview of allocation of banks funds to different types of assets and to examine the impact of portfolio of assets on liquidity, solvency, credit risk and profitability of the commercial banks. The study was confined to the listed commercial banks at Dhaka Stock Exchange only. The sample of this study contained 20 commercial banks, which was accounted for 74.07% of the population. The main basis of the selection of the sample is the easy access and availability of the requisite data and information. The study covered a period of seven years from 2000 to 2006. The study was based on secondary data. Those data were collected from annual reports of the selected banks, Bangladesh Bank reports and from Resume of the Activities of Financial Institutions in Bangladesh published by the Ministry of Finance, Government of Bangladesh. The study followed both time series and cross-sectional analysis. Initially, the study presented the mean values of important growth indicators such as asset, deposit, loan and equity of each commercial bank with their period growth. Then major asset composition of the selected commercial banks were exhibited. Impact of asset compositions on liquidity, profitability, credit risk and solvency of those banks were illustrated next. The study continued the same analysis by splitting the sample banks in large, medium and small groups in terms of their total assets value based on 2006. The sample commercial banks were classified again in private commercial banks (PCBs) and de-nationalized commercial banks (DCBs) based on their ownership status to continue the same analysis. A huge infected loan portfolio has been the major difficulty of commercial banks. It appears that in aggregate, the banks have been continuously failing to maintain the required level of provisions against their NPLs. Liquidity indicators show a massive decreasing trend during the study period. The commercial banks of Bangladesh could not attain the required level due to shortage in owner's equity, provision shortfall and overburdened expenditure incurred from operation time to time. Hence, tl1e focus of the study is to provide an overview of allocation of banks funds to different types of assets and to examine the impact of portfolio of assets on liquidity, solvency, credit risk and profitability of the commercial banks. The study was confined to the listed commercial banks at Dhaka Stock Exchange only. The sample of this study contained 20 commercial banks, which was accounted for 74.07% of the population. The main basis of the selection of the sample is the easy access and availability of the requisite data and information. The study covered a period of seven years from 2000 to 2006. The study was based on secondary data. Those data were collected from annual reports of the selected banks, Bangladesh Bank reports and from Resume of the Activities of Financial Institutions in Bangladesh published by the Ministry of Finance, Government of Bangladesh. The study followed both time series and cross-sectional analysis. Initially, the study presented the mean values of important growth indicators such as asset, deposit, loan and equity of each commercial bank with their period growth. Then major asset composition of the selected commercial banks were exhibited. Impact of asset compositions on liquidity, profitability, credit risk and solvency of those banks were illustrated next. The study continued the same analysis by splitting the sample banks in large, medium and small groups in terms of their total assets value based on 2006. The sample commercial banks were classified again in private commercial banks (PCBs) and de-nationalized commercial banks (DCBs) based on their ownership status to continue the same analysis. A huge infected loan portfolio has been the major difficulty of commercial banks. It appears that in aggregate, the banks have been continuously failing to maintain the required level of provisions against their NPLs. Liquidity indicators show a massive decreasing trend during the study period. The commercial banks of Bangladesh could not attain the required level due to shortage in owner's equity, provision shortfall and overburdened expenditure incurred from operation time to time. Hence, tl1e focus of the study is to provide an overview of allocation of banks funds to different types of assets and to examine the impact of portfolio of assets on liquidity, solvency, credit risk and profitability of the commercial banks. The study was confined to the listed commercial banks at Dhaka Stock Exchange only. The sample of this study contained 20 commercial banks, which was accounted for 74.07% of the population. The main basis of the selection of the sample is the easy access and availability of the requisite data and information. The study covered a period of seven years from 2000 to 2006. The study was based on secondary data. Those data were collected from annual reports of the selected banks, Bangladesh Bank reports and from Resume of the Activities of Financial Institutions in Bangladesh published by the Ministry of Finance, Government of Bangladesh. The study followed both time series and cross-sectional analysis. Initially, the study presented the mean values of important growth indicators such as asset, deposit, loan and equity of each commercial bank with their period growth. Then major asset composition of the selected commercial banks were exhibited. Impact of asset compositions on liquidity, profitability, credit risk and solvency of those banks were illustrated next. The study continued the same analysis by splitting the sample banks in large, medium and small groups in terms of their total assets value based on 2006. The sample commercial banks were classified again in private commercial banks (PCBs) and de-nationalized commercial banks (DCBs) based on their ownership status to continue the same analysis. A huge infected loan portfolio has been the major difficulty of commercial banks. It appears that in aggregate, the banks have been continuously failing to maintain the required level of provisions against their NPLs. Liquidity indicators show a massive decreasing trend during the study period. The commercial banks of Bangladesh could not attain the required level due to shortage in owner's equity, provision shortfall and overburdened expenditure incurred from operation time to time. Hence, tl1e focus of the study is to provide an overview of allocation of banks funds to different types of assets and to examine the impact of portfolio of assets on liquidity, solvency, credit risk and profitability of the commercial banks. The study was confined to the listed commercial banks at Dhaka Stock Exchange only. The sample of this study contained 20 commercial banks, which was accounted for 74.07% of the popula The techniques employed to study the relationship between the variables ranged from simple descriptive statistical tools like mean, period growth, maximum and minimum value to complex techniques like correlation and regression analysis. Although the concept of portfolio management is not quite new in Bangladesh but the fact is that very few research works have been done in this area. There has been no study as to how the banks performed in liquidity, profitability, credit risk and solvency during 2000-2006. The previous studies on profitability and other measures are far from satisfactory. Those studies used neither statistical technique nor made inter-temporal and inter-bank comparisons with different categories of commercial banks. So, the present study intends to evaluate the portfolio behavior of commercial Banks by using the above mentioned criteria. This study is different from earlier studies with respect to contents, coverage of years and methodology. The discussion on portfolio composition and its impact on liquidity, profitability, credit risk and solvency were made in three parts. In part one, portfolio behavior of individual commercial bank was exhibited. In second part, the same discussion was made on three different sizes of banks. Part three analyzed portfolio behavior of PCBs and DCBs. It is evident from the study that all types of banks preferred to provide more funds as loan for making more income and profit. Among the different bank groups, DCBs achieved the highest PG in ROA in last seven years although loan to total asset ratio of this group of banks showed negative during the study period. So, loan had no capability to influence profitability of DCBs. But the study found a statistical significance between loan and profitability for the sample commercial banks. There exists a significant correlation between the variables in case of SCBs also. However, in both the cases, profitability is negatively correlated with loan. So, increase of loan in the study has produced a result of decrease in profitability. However, employment of lions' percentage of funds in loans and investments means fewer funds were available for maintaining minimum liquidity for the banks. Liquid assets in relation to total assets of sample commercial banks have alarmingly decreased by 47.05 percent during the same period. So, liquidity of sample commercial banks is negatively related with loan. Correlation and regression analysis also go in favor of the hypothesis. However, liquidity scenario is noticed more appalling for SCBs and PCBs as compared to MCBs, LCBs, and DCBs. But except LCBs, the study found no statistical relationship between liquidity and loan variable in those cases. On the other hand, since loans are considered as one of the risky assets, so the banks were involved in more credit risk and they were forced to keep more provision against their loan losses. But the study observes an encouraging (declining) trend in NPL to total loan ratio for all groups of banks during the years under review. LCBs were able to reduce their credit risk to a large extent. They are followed by SCBs and PCBs. But the study found no statistical significance between loan and credit risk for LCBs and DCBs. In rest of the cases there exists a positive correlation between credit risk and loan of the commercial banks. So, according to the study, providing more loans means inviting more credit risk. However, what is annoying for the banks is that their risk-weighted asset has increased alarmingly during the years under review as compared to their capital. Since loan is considered as one of the most risky assets, so provide more loans means inviting more risk-weighted assets for the commercial banks. Accordingly, they were required more capital for maintaining a minimum CAR (solvency). But during the years under review, the study found a decreasing trend in CAR. But the study found no statistical significance between loan and credit risk for MCBs, LCBs and DCBs. In rest of the cases there exists a negative correlation between solvency and loan of the commercial banks. So, according to the study, additional loans created shortage of solvency for the banks. The overcome the problems, the study suggests for strong monitoring of Bangladesh Bank over commercial banks to ensure that they maintain minimum liquidity reserve. The study further suggests for allowing DCBs to raise new capital from security market for investment to arrest the declining trend of profitability; initiating efforts that can provide more information regarding credit­worthiness of borrowers. To improve the knowledge in assessing risks, the banks should invest more funds in credit research and monitoring. The study further recommends for imposition of minimum CAR requirement of the commercial banks which will contribute to a decrease in the banks' willingness to supply loans. This situation would lead commercial banks tend to put their excess liquidity in low risk assets. The study concludes that providing more loans of the sample banks is very much dependent on their additional deposit collection. But more lending does not always give the guarantee to earn more profit to them. Rather it creates more credit risk and more pressure to maintain a minimum CAR (solvency) for the commercial banks.